Many landowners in Oklahoma and Texas have experienced varying degrees of damage from weather events this spring and summer. Destruction has come in many ways. Winds have damaged or demolished buildings. Flooding has flattened fences by piling up debris. Rock and gravel on internal roads have disappeared while ruts remained due to travel during wet conditions. Landowners making repairs and rebuilding will incur cost. How will these be reported on the 2015 tax return?
There are basically two ways to report expenses as a result of damage. The two ways are 1) expenses incurred on tangible property in carrying on a trade or business are capitalized or deducted as a repair or 2) report the damage as a causality. In order to deduct as a causality, there has to be a basis in the asset. Also, if insurance proceeds are received, many times a gain results rather than a loss. For purposes of this article only expenses incurred on tangible property will be discussed.
If an expense qualifies as a repair, it is reported on the repair line on the bottom of the Schedule F form of the tax return if you have a farming business. The Internal Revenue Service (IRS) will generally allow this categorization if the expense did not result in a betterment or an adaption of the property to a new or different use. In the case of a fence, if a landowner had to hire labor and/or equipment to clean debris from a fence then buy posts and wire to rebuild the fence, all the expenditures will likely be deductible as labor, machine hire or repairs in the year incurred if the fence serves the same purpose after as it did before.
However, a landowner may decide that they want a better water gap. Every time a big rain comes, they have to deal with trying to fix the hole before the cattle find it. They know that good fences make good neighbors, and they want to be a good neighbor. So the landowner takes this opportunity to build a water gap that withstands greater water flow and keeps the cattle in without reoccurring attention and expense. In this case, the expenditures would have to be capitalized and depreciated because they improved the existing water gap.
As a sidebar, it should be mentioned that the IRS code section 179 expensing election is still available. This election allows a taxpayer to expense or deduct expenditures in the year incurred that would normally be capitalized and recovered over a period of years through depreciation. Farmers, ranchers and business owners have been allowed to elect up to a maximum of $500,000 in one year. However, that amount expired at the end of 2014 and the maximum for 2015 is $25,000. That is, unless Congress decides to pass an extenders bill, as they did last December, to increase the amount. The new improved water gap and many other items such as breeding stock, tractors and equipment are eligible for the Section 179 election.
Expenditures used to hire machinery and purchase rock or gravel to repair the internal roads would be deductible in the year incurred as long as the roads were similar after as they were before.
The IRS provides de minimis safe harbor exceptions to the capitalization rules for eligible taxpayers. The IRS has issued several regulations in 2013 and 2014 to help clarify, simplify and refine, as well as to create several new safe harbors.
These are general rules that apply; however, every taxpayer is unique and has their own individual situation. It is a good idea for each affected landowner to seek council from his or her tax preparer.